7 Tips on How to Choose the Right Debt Funds to Earn Maximum Profit

A debt fund investment is a crucial part of your investment portfolio. Unlike equity funds which are based on volatile market conditions, debt mutual funds park your money in safer alternatives such as government bonds. They are the ones on which you can fall back in times of crisis. So you would not want to make any mistakes while investing in them.

Being less risky doesn’t mean that you can invest in any debt mutual fund. This article tells you how to select debt mutual funds that are suitable to you based on some universal and some individual factors.

7 Tips on Choosing the Right Debt Funds According to 7 Key Parameters

Look out for these 7 characteristics while selecting a debt fund investment.

1. Your Investment Capacity

Every investor has different strengths and weaknesses. Some can hold money for a long time. Others need instant returns. There are risk takers and deep thinkers in the market. Therefore, you need to analyse different aspects of your financial profile before investing.

Ask yourself questions like how much you can invest and for how long? What is your risk appetite? Answering these questions will collectively decide the suitable debt fund investment for you.

2. Interest Rate Fluctuation

Fluctuating interest rates can confuse a layman. Don’t fall for technical jargon if you are not from a financial background. Understand a simple fact – The interest rate of your fund fall and rises according to the fall and rise of the overall interest rate in the economy.

You can rely upon acquiring new debt mutual funds when interest increases in the market. And hold on to your existing funds when the rate of interest (ROI) goes down.

3. Average Maturity of Debt Funds

Check out the average maturity of the debt funds you are eyeing. It is the weighted average of the maturities of all the securities currently held by the debt mutual fund. The modified duration is formed because of the fund’s sensitivity to the significant changes in the market.

Debt funds with higher average bond maturity and modified duration provide good returns during falling interest rates. And lower maturity debts perform better when ROI is rising.

4. Yield to Maturity

A debt mutual fund’s average yield to maturity (YTM) provides a fair idea of the interest gain at the end of your fund maturity if its entire portfolio is held till maturity. The debt fund investments in fixed income instruments provide better YTM.

The net yield to maturity is a strong indicator of the profit from a fund. You get that by deducting the debt fund expense ratio from its gross YTM.

5. Macaulay Duration

If you are not a risk taker, the answer to how to choose a debt fund can be simple for you. The one with the least Macaulay duration is probably the one for you! It’s the duration in which you will recover your invested principal amount from the internal cash flow. It is the earning from the bonds through interest and repayments.

6. Credit Rating

Another indication of safe funds for conservative investors is the credit rating. Rating agencies categorise all the holdings of debt funds based on their credit quality. The general ratings are A1+. AAA and AA+. The fund with a maximum share of AAA-rated holdings is low on risk and can be considered high quality.

7. Debt Fund Expense Ratio

The expense ratio of a debt fund is the ratio of its overall assets utilised to fulfil its overall expenses. The income which can be generated through debt fund investment in a short duration doesn’t even come close to the kind of profit that equity funds yield in a low duration.

However, debt mutual funds with low expense ratios, such as direct plans, provide better results from a low-duration investment. That’s why you should look for an expense ratio when you want to make a short-duration liquid investment.

Make an Informed Decision!

Factor in your risk-taking ability, financial goal, and market knowledge, and keep the above 7 things in mind before making any debt fund investment. Also, don’t make any decisions in a rush or blindly follow someone else’s advice.

And yes! The age-old saying goes a long way in making the right financial choices: “never put all your eggs in one basket.” Always diversify your investment.

About the Guest Author

guest author

Naina Rajgopalan has a thing for numbers and a deep fascination to learn about all things finance. She’s been money-wise from a young age and has always shared her knowledge and tips with those around her.

Being a part of the content team at Freo Save, a neobank that offers a 7% interest rate on savings along with benefits such as insurance on balance, safe & secure banking, and so on, Naina stays updated with the latest of what happens in the banking and fintech industries.

She has taken upon herself to share her knowledge with readers across all walks of life to help them manage their finances and budgets better, so they can make better decisions while spending, borrowing, investing and saving.


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